Tuesday, January 3, 2012


Over the last few years I've come to believe that all income, earned and unearned, should be taxed at the same rate, that preferential taxation of capital no longer leads to the intended policy effects of job creation and increasing capital investment in plant. property and equipment but rather is a bought-and-paid-for scam perpetrated by the financier class.

On a related point, it's time to get rid of the carried interest loophole which taxes income at cap gains rates for private equity and hedge funds.
That carried interest should not be treated as a capital gain can be proven quite easily.
Show me one tax return where a carried interest capital loss was allowed.
[you won't be invited to any of the meetings ever again -ed]

At the lower end of the income scale there should be some minimum tax. Everyone should have some skin in the game.
I'll be coming back to all these topics throughout 2012, in the meantime here's the granddaddy of Econ papers for folks interested in this stuff, sincere thanks to the reader who turned my vague recollection of the thesis into an actual PDF copy. It is as pertinent and fresh today as the day it was written, 34 years ago.
By Mason Gaffney
A paper delivered to the National Tax Association, Chicago, August, 1978.
Adapted for use in a course in Macro-economics, Winter, 1996.

We hear a lot these days about the need for more capital to make jobs. Some of what we hear and read we may discount as self-serving, lobbying for more preferential tax treatment of profits. Yet there is a case argued by sincere and public-minded people on objective grounds which we must take seriously.

It had better be a good case, because it goes far toward destroying the progressivity case, the one on which the American public has bought the income tax concept. Preferential income tax treatment of property income cuts off the top brackets of income receivers from tax liability, especially when we exempt capital gains. Preferential treatment exempts or favors the unearned increment to land values, especially again when we favor capital gains. The thrust of proposals being seriously advanced today is to convert the income tax into simply another payroll tax, socializing a large share of personal effort while eliminating the public equity in the land and capital resources of the nation.

Preferential tax treatment for property also destroys the neutrality or uniformity argument for income taxation. It encourages substituting capital and land for labor. It forces higher rates on personal effort, thus weakening the incentive to work while maximizing the incentive to lobby in legislatures and the Congress for public works and other federal outlays which create unearned increments to land values.

Are these hardships necessary to stir investors to make jobs? This paper outlines an alternative thesis that the misuse of capital, rather than simple shortage, is to blame for lack of jobs. The key to making jobs is changing the use and form of capital we already have. Tax preferences for property income, in their present and proposed forms, bias investors against using capital to make jobs, doing more harm than good.

Adam Smith stated the present thesis clearly:
The number of... laborers is...in proportion to the quantity of capital stock which is employed in setting them to work, and to the particular way in which it is so employed."
"The quantity of labor which equal capitals are capable of putting in motion, varies extremely according to their employment." ... "A capital employed in the home trade will sometimes make 12 operations, or be sent out and returned 12 times, before a capital employed in the foreign trade...has made one" 1
1 Adam Smith, Wealth of Nations, pp.. 338, 341, 349.

Adam Smith here refers to capital as stock in trade. For making jobs, fixed capital frozen in buildings or turnpikes is so slow returning that Smith does not bother mentioning it. Smith was following Fran├žois Quesnay, who had written a little earlier that capital stored up in advance is an indispensable precondition for capitalists to make jobs. After Smith, Ricardo developed the theme further. He asks what would happen if a big fraction of our capital is diverted from circulating (fast- turning) forms to "fixed" (slowturning) forms, exemplified by "machinery."

He paints a grim scenario of the answer: 
"the gross produce will have fallen from a value of 15,000 to a value of 7500; and as the power of supporting a population, and employing labour, depends always on the gross produce of a nation, and not on its net produce, there will necessarily be a diminution in the demand for labour, population will become redundant, and the situation of the labouring classes will be that of distress and poverty".2
John Stuart Mill makes Ricardo's point a little sharper. Like Ricardo, he distinguishes fixed from circulating capital:
"capital may be temporarily unemployed, as in the case of unsold goods ... during this interval it does not set in motion any industry ... Capital is kept in existence from age to age not by preservation, but by perpetual reproduction. ... To set free a capital which would otherwise be locked up in a form useless for the support of labor, is, no doubt, the same thing to the interests of laborers as the creation of a new capital.
Capital ...in unsold goods does not set in motion any industry. Capital may be so employed as not to support laborers, being fixed in machinery, buildings,... locked up in the form useless for the support of labor.
Suppose half (one's capital) effects a permanent improvement. ... He will employ next...year only half the number of laborers"3

That is, he doesn't get his money back from the permanent improvement next year; it is like "unsold goods." Therefore, he has no liquid funds to meet another payroll. The "permanent improvement," however useful over its full life, remains "unsold goods" next year. The effect is the same as though he were left with a warehouse full of togs or toys that would not sell. A monetarist economist might object that the money could be printed by a friendly central bank. Mill would answer that this funny money would not deliver any final goods to consumers, and therefore only drive up prices. He had not learned to accept inflation with the same facility as we have today (1978), or to regard it as anything but a fraud. Monetarists and Keynesians have mocked Mill for this fun-spoiling attitude, but th epresent "stagflation" - the outcome of unlimited demand-side economic policy - makes one realize they might still learn from Mill.
2 David Ricardo, Principles of Political Economy and Taxation (1817), p.272.
3 John Stuart Mill, Principles of Political Economy, (1872), pp. 41-63, passim. See also J. S. Mill, Essays
on Some Unsettled Issues of Political Economy (1874), pp. 55-59.

W. Stanley Jevons resented the authority accorded to Mill and Ricardo, and attacked them. The drama of personal vendetta, and the neo-classical compulsion to cast out Ricardo and Mill, have spawned a false view that Jevons departed from them. Here, however, is what Jevons actually wrote in his Chapter VII, "Theory of Capital":
"The views which I shall endeavour to establish on this subject are in fundamental agreement with those adopted by Ricardo; ... The same capital will serve for twice as much industry if it be absorbed or invested for only half thetime"4.
Jevons develops the last sentence at some length, in a simple mathematical model centered on the concept of a period of investment. Before his premature death, he was trying to turn this into a full explanation of boom-bust cycles. Jevons is the channel between English and Austrian economists. It was a two- way channel: modern Austrians still express one of their major concepts as "Ricardo Effect."
Karl Marx, a student of classical political economy, expressed what seems like the same idea in different words. He wrote of the "organic composition of capital," meaning the degree to which it is fixed rather than circulating. He devotes all of Book II of Das Kapital to treating the turnover of capital. He gets so wound up in it, however, it is hard for this reader, at least, to be sure where he comes out. Modern Marxist writers, not reviewed here, have taken up his views at length. These include Shaikh, Yaffe, Fine and Harris, Bell, and Weisskopf. Sherman (1995) remarks the common themes in Marx and the Austrians. This commonality did not abate the Austrians' militant anti- Marxism. Knut Wicksell, who developed these ideas more fully and formally, is cited near the end of this essay.
Ludwig Von Mises and Friedrich Hayek, second-generation Austrian-school economists, advanced ideas derived from those cited, and were prominent in the 1920s and early 1930s, before Keynes. However, their variations on the theme modified it and, in my view, muddied it considerably, and I will not cite them here.
Smith, Ricardo, Mill, Jevons and Wicksell make enough sense, and represent enough collective wisdom, to attract our attention. In their model, a shortage of job-making capital has two causes, pointing to two different solutions. They direct our attention away from the cause we hear most about today, a simple shortfall in quantity of capital. Let's identify and remember this idea of simple quantity shortage as "Theorem A." If we buy Theorem A, the obvious solution is to get more capital, in whatever form. The classical economists' ideas point, rather, to a "Theorem B." Theorem B says that unsold goods return no capital to meet the next payroll. It says more: the reason goods are unsold is because they are not ready to sell, being fixed in machinery and buildings. They are "unripe." Inadequate demand is not the problem, at least not initially. Unripeness of supply is the initiating problem.
4 William Stanley Jevons, The Theory of Political Economy (1871), Chp. 7, par VII.2 (pp. 222, 229 1st Ed.)

The solution proposed most vocally now in Washington is based on Theorem A.
It is to exempt property income from taxation, with the promise that this will boost capital formation, and this in turn will make jobs. Less is said about the necessary counterpart, to shift taxes to wages and salaries and other compensation for personal service and effort, and to employers as their share of the payroll tax. This implied-but-unadvertised counterpart would, of course, directly destroy jobs.

This method would seem to give away more to property than is needed to accomplish the goal of making jobs. It exempts land income, especially when preferential treatment of capital gains is emphasized. (The investment tax credit, and accelerated depreciation for new construction are free of this last criticism, however.) This method in practice also exempts capital overseas, which really should be called home if the purpose is to make jobs in our own country. Exporting capital makes one-shot American jobs producing the capital; but to operate capital makes jobs where the plants are located.

This method - preferential tax treatment of capital - perpetuates and gives another twist to structural distortions that misallocate capital and tie it up in labor-saving forms in highly capital-intensive industries and activities. Some examples of this are premature streets and water supply systems financed by tax-free municipal bonds. Tax-sheltered exploration for oil and gas is another example: this ties up capital for decades before recovery. In time this capital flows back to us as usable energy; but cheap energy substitutes for labor, and complements capital (like farm tractors and pumps) in downstream uses. Yet another example is timber allowed to regenerate naturally, i.e. without the labor of planting: this ties up land for 80 to 150 years under each crop, with minimal use of labor.

Worse yet, this method shifts the tax burden to payrolls, driving a deeper tax-wedge between the payroll and the dinner-table. This wedge induces employers to substitute capital for labor, and causes many potential workers to prefer untaxed welfare, crime, or the pursuit of charity and unearned income to productive labor....MORE (17 page PDF)
Now that I've raised some hackles on the right let's talk about taxing foundations, trusts and NGO's...

In the meantime here's professor Gaffney's website and blog (last updated 2010).